The dematerialization of shares and introduction of settlements in demat form changed the face of the Indian stock markets. The net major reform in the new millennium affecting the stock markets was introduction of rolling settlement (RS).
This concept is not new to the Indian stock market, OTCEI as the first exchange to introduced rolling settlement when it started operations in 1992. Rolling settlement was not a success on OCTCEI as there was no margin trading facility for borrowing funds or shares.
Rolling settlement was introduced by SEBI for the first time in January 2000 in selected scrips. Initially, 10 scrips were brought under rolling settlement. Subsequently on March 8, 2000, 153 more scrips were introduced. Rolling settlement was introduced in the form of T+5 settlement system where “T” is the trade date and ‘5’ is the number of business days after date on which delivery of securities and cash payments are due for settlements. In other words, T+5 means that all open positions at the end of trading date result into delivery and payment five working days after. If trading takes place on Thursday, it will be settled the following Thursday, so on and so forth. This cycle would be rolling and hence there would be a set of transactions for delivery every day. Thus, rolling settlement means converting the market into a cash market, since each day’s transaction is settled in full.
The following table illustrates weekly settlement and rolling settlement
Date: Weekly Settlement: T+5 Rolling Settlement
1: Buy 200 shares: Buy 200 shares
2: Sell 100 shares: Sell 10 shares
6: — : Pay for 200 shares and
get the shares
7: — : Deliver 100 shares and
get paid for them
14: Pay the net price for 100 shares: —
15: Get 100 shares: —
Rolling settlement system replaced the badla system from July 2, 2001. On July 2, 2001, 215 scrips were brought under the riling systems, bringing the total to 414 scrips. By January 2,2002 all scrips were brought under compulsory rolling mode. Internationally most developed countries follow a T+3 cycle and are aiming to move to a T+1 cycle (next day settlement) or a T+0 cycle where trades are settled on the day they are executed (same evening settlement). This is system of T+0 is prevalent in Switzerland and volumes are phenomenal when compared to the T+3 system. Indian stock markets moved to the T+3 system from April 2002, in line with the recommendations of the “Group of Thirty” which suggested it as minimum international standard.
Advantages of rolling Settlement: The advantages are:
1. The basic advantage of rolling system over the badla system is its simplicity. The badla system was non-transparent and unregulated and the investors’ exposure to risk and fraud was very high. The investor had to keep track of different stocks as they had different settlement systems. With rolling settlement the investor has to merely keep track of the day of purchase/sale of scrips as all the scrips are settled in the same format on all trading screens.
2. This system eliminates arbitrage opportunities in scrips.
3. It improves the price discovery process as the settlement process is standardization and the participants can focus more on market outcomes.
4. This improvement in price discovery would lead to a single, well defined price that can be used for information processing by different economic agents.
5. IT reduces settlement risk and narrows the bid-ask spreads (difference between the bid and offer prices) due to its transparent nature.
6. It encourages wider participation as institutional investors forbidden from doing badla or netting trades within a settlement can now take advantage of this system as it shortens delay in settlement of transactions.
7. It eliminates fluctuations of price which take place around settlement dates. With the setting up of clearing corporations, rolling settlement reduces the working capital requirements of brokerage firms.
8. As it reduces price manipulation and arbitrage, it helps in reducing volatility and turbulence in the markets.
9. Finally, retail investors benefit as it shortens the delays for converting securities into cash and vice versa.
It is perceived that rolling settlement liquidity as it reduces speculation and arbitrage. This reduction in liquidity may be a short term feature as investors and brokers need time to adjust o this new system and to digest the fact that they do not get any leverage. In rolling settlement one cannot short sell a scrip which creates an impact on liquidity.